5 Tips for Negotiating Effective Insurance Provisions in Commercial Leases
The ultimate goal for both a landlord and a tenant in negotiating risk-shifting provisions in a lease is to get the best insurance coverage to protect the property of each and to allocate between themselves the responsibilities for those coverages in a way that will result in the lowest collective cost.
1. Focus on Shifting Risk
Accomplishing this goal requires the parties to view themselves as a team of two parties playing against the insurance company as opposed to landlord and tenant against each other. This benefits both parties since the tenant is paying for the total cost of insurance anyway either through gross rent or additional rent.
As a general rule, each party should carry insurance on property that it owns, with the landlord carrying insurance on the real property and improvements and the tenant carrying insurance on its contents and other personal property. Regardless of whether the landlord’s negligence results in a roof leak that damages a tenant’s copy machine or whether tenant’s employee drives a car through the front door of the building, each party should be willing to look to its insurance for coverage of these losses.
An example of a poor negotiation tactic driven by well-meaning intent is the frequent attempt to exclude negligence of one party or the other from the waiver of claims provision. Each party should agree to waive its right to claims for damage to its property arising out of the negligence or wrongful act of the other party. This may seem counterintuitive, but in fact supports the underlying goal of the parties to remove the risk from each other, regardless of whose fault caused the loss, and shift the risk to the insurance carrier. If properly drafted, the waiver of claims and waiver of subrogation provisions working together should remove fault as a factor without increasing either party’s costs or diminishing coverage.
2. Understand the Operative Clauses
Risk management professionals must breathe a heavy sigh of frustration each time a client sends a request to approve a snip of an insurance provision of a lease. Since the insurance provision tells only part of the story, it’s important to understand that other provisions of the lease, such as those relating to waiver of claims, waiver of subrogation rights, and indemnities all must be reviewed to effectively assess risk. All of these work together, and if drafted properly, play a perfect symphony of risk-shifting notes.
Some key issues to watch out for are to make sure the required insurance limits are appropriate to cover the value of the property being insured, require each party to adequately insure its own property, limit waiver of claims provisions to property damage only and do not include waivers related to personal injury, and negotiate mutuality of the waiver of claims and waiver of subrogation rights.
3. Don’t Over-Insure
A common example of where parties go astray is when some leases require tenants to insure their own leasehold improvements. This may seem fair at first glance if each party believes it should insure its own property, but upon analyzing more carefully, one should realize that a landlord’s property and casualty insurance covers the property as improved, including the leasehold improvements, so it doesn’t make sense to require both parties to insure for the same potential loss.
4. Beware of Mutuality
The indemnification provisions are another area where tenants frequently request mutuality without understanding the impact the request would have if granted. The tenant typically agrees to indemnify the landlord against any loss occurring inside the premises (since the tenant insures its contents and carries liability insurance for acts occurring inside the premises). If the provision were made strictly mutual, the tenant would in effect be increasing its own costs because the landlord would have to then carry additional insurance for acts occurring inside the premises, or for the tenant’s contents, in which case the landlord’s insurance costs, which are passed through to tenants, would also increase. The appropriate way to accomplish “mutuality” of indemnity provisions is to have the landlord indemnify tenant for losses occurring in or on the common areas since landlord’s insurance covers acts occurring in the common areas.
5. Understand the Appropriate Policies
The terms “business interruption insurance” and “rent loss insurance” are often used interchangeably. This is understandable since they do both cover losses resulting from a casualty that renders a tenant’s premises untenantable. However, they are not the same. The first covers the tenant’s liability to pay rent during the down time caused by the casualty, and the second covers the landlord for any rent that is not received due to a casualty.
Because these types of insurance cover either tenant’s obligation to pay rent or landlord’s loss in not receiving rent, you might imagine that whether rent is abated in the event of a casualty is also relevant. Accordingly, when considering whether rent should be abated in a given situation, the parties should consider who would bear the loss of that abatement and whether insurance should be carried by either the landlord or the tenant to cover that loss. The availability of business interruption insurance is also an important consideration when negotiating whether a tenant should have a right to terminate during a period when it cannot use the premises. If the parties can shift the risk of that down time to a third party, then the collective loss to the parties is significantly reduced as compared to tenant having a right to terminate the lease, thereby leaving landlord without a rent stream or rent loss coverage for the time period following lease termination. The fair allocation of risk is for each party to carry the respective policy and forego any lease termination right.
Notably, some leases provide that rent does not abate if the tenant caused the loss. While such a term appears to be “fair” since it is hard to argue that a misbehaving tenant should get the benefit of a rent abatement, the problem with it is that if there is no abatement, and the tenant fails to pay, then the landlord may not be able to recover under its rent loss policy. One might argue that the only party who wins here is the insurer. This is yet another example of the parties’ assignment of fault diminishing their potential collective recovery.
Stephanie Friese is co-managing shareholder in the Atlanta office and chair of the Real Estate Practice Group of Chamberlain Hrdlicka. She advises commercial landlords and tenants in more than 38 states and internationally.